California Coast Univ BAM 313-Introduction to Financial Management 1. Maximization of shareholder ...

Introduction to Financial Management

1. Maximization of shareholder wealth as a goal is superior to profit maximiza-

tion because:

a. it considers the time value of the money.

b. following the goal of shareholder wealth maximization will ensure high stock

prices.

c. it considers uncertainty.

d. A and C

2) Which of the following is NOT true for a limited partnership?

a. Limited partners may sell their interest in the company.

b. Limited partners can only manage the business.

c. One general partner must exist who has unlimited liability.

d. Only the name of general partners can appear in the name of the firm.

3) Revenues are taxed

a. to achieve socially desirable goals.

b. to provide revenues for government expenditures.

c. for economic stabilization.

d. all of the above

4) Which of the following categories of owners have unlimited liability?

a. general partners in a limited partnership

b. sole proprietors

c. shareholders of a corporation

d. both A and B

5) Emery Inc. had $5 million of gross income, operating expenses of $1 million,

paid $1 million of interest on borrowing of $10 million, and paid a dividend

of $0.50 million. Emery Inc.’s taxable income is

a. $4 million.

b. $3 million.

c. $3.5 million.

d. $2.5 million.

Multiple Choice Questions (Enter your answers on the enclosed answer sheet)2

Final Examination

Introduction to Financial Management

6) Given the following tax rate schedule, what is the tax liability for a corpora-

tion with taxable income of $8 million?

Corporate Tax Rates Taxable Income

15% $0 - $50,000

25% $50,001 - $75,000

34% $75,001 - $10,000,000

35% over $10,000,000

Additional surtax of 5% on income between $100,000 and $335,000

Additional surtax of 3% on income between $15,000,000 and $18,333,333

a. $2,715,000

b. $2,720,000

c. $2,694,500

d. $2,708,250

7) Company A reports sales of $100,000 and net income of $15,000. Company

B reports sales of $100,000 and net income of $10,000. Therefore:

a. Company A’s cash flow may be higher or lower than Company B’s cash flow

even though A’s net income is higher.

b. Company B is creating less value for its shareholders than Company A.

c. Company B’s accounts receivable must be higher than Company A’s accounts

receivable.

d. Company A’s cash flow is $5,000 more than Company B’s cash flow.

8) The CEO of High Tech International decides to change an accounting method

at the end of the current year. The change results in reported profits increas-

ing by 5%, but the company’s cash flows are not changed. If capital markets

are efficient, then:

a. The stock price will increase due to higher profits.

b. The stock price will not be affected by the accounting change.

c. The stock price will decrease because accounting method changes are not

permitted under generally accepted accounting principles.

d. The stock price will increase only if the accounting change will also result in

higher profits in the next year.

9) The curse of competitive markets

a. May be lessened by obtaining patents for new ideas that protect companies

from competitors.

b. Implies that profitable industries will become smaller as companies drop out

to avoid competition. Final Examination

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Introduction to Financial Management

c. Means that money spent on innovation is wasted because competitors will

rush in and eliminate any excess profits.

d. Means that companies cannot earn exceptional profits.

10) Which of the following statements best represents the “Agency Problem”?

a. The agency problem results from the separation of management and the own-

ership of the firm.

b. The agency problem may interfere with the implementation of maximizing

shareholder wealth.

c. Managers might attempt to benefit themselves in terms of salary and perqui-

sites at the expense of shareholders.

d. all of the above

11) U.S. corporations finance their activities

a. mainly with equity because equity does not expire or need to be paid back.

b. mainly with equity because the U.S. tax system favors equity over debt.

c. mainly with corporate debt, partially because the U.S. tax system favors debt

over equity.

d. equally with debt and equity.

12) All of the following securities are sold in money markets except:

a. 6-month certificates of deposit

b. common stock

c. commercial paper

d. 3-month U.S. Treasury Bills

13) Which of the following is an advantage of organized stock exchanges?

a. Only profitable companies may issue new securities on an organized ex-

change.

b. screening companies to ensure only low risk stocks are sold

c. providing a continuous market

d. increased stock price volatility

14) An example of a secondary market transaction involving a capital market

security is:

a. The transfer of a previously-issued security with a very long maturity.

b. The transfer of a previously-issued security with a very short maturity.

c. A new issue of a security with a very short maturity.

d. A new issue of a security with a very long maturity.4

Final Examination

Introduction to Financial Management

15) Money market transactions include which of the following?

a. Securities that have a maturity of less than one year

b. All securities paid for with the proceeds of a money market account

c. 30-year U.S. Treasury bonds

d. Any security that is paid for with cash

16) Private placements are

a. especially appealing to new, small, and medium-sized companies.

b. limited to equity securities.

c. available for both debt and equity securities, but the market is dominated by

equity issues.

d. limited to debt securities.

17) The Sarbanes-Oxley Act of 2002, in order to protect investors, requires a

higher level of accountability for which of the following groups?

a. corporate officers

b. boards of directors

c. public accountants

d. all of the above

18) What was the average annual rate of return on 3-month U.S. Treasury bills

during the period 1981 to 2005?

a. 10.4%

b. 5.68%

c. 3.84%

d. 6.99%

19) Which of the following securities will likely have the highest default risk pre-

mium?

a. U.S. Treasury Bill

b. Bbb-rated corporate bond maturing in 2020 actively traded on a major ex-

change

c. Aaa-rated corporate bond maturing in 2015 not actively traded

d. U.S. Treasury Bond maturing in 2027

20) The real rate of return is the return earned above the

a. variability of returns measured by standard deviation.

b. inflation risk premium.

c. default risk premium.

d. risk-adjusted return. Final Examination

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Introduction to Financial Management

21) Li Retailing reported the following items for the current year: Sales =

$2,000,000; Cost of Goods Sold = $1,200,000; Depreciation Expense =

$140,000; Administrative Expenses = $170,000; Interest Expense =

$40,000; Marketing Expenses = $60,000; and Taxes = $20,000. Li’s gross

profit is equal to:

a. $410,000

b. $800,000

c. $490,000

d. $430,000

22) Which of the following statements concerning net income is most correct?

a. Negative net income reduces a company’s cash balance.

b. Net income represents sales minus operating expenses at a specific point in

time.

c. Net income represents cash available to pay dividends.

d. Net income represents income that may be reinvested in the firm or distrib-

uted to its owners.

Table 3-1

Jones Company Financial Information

December 2007 December 2008

Net income $2,000 $5,000

Accounts receivable 750 750

Accumulated depreciation 1,000 1,500

Common stock 4,500 5,000

Paid-in capital 7,500 8,000

Retained earnings 1,500 2,500

Accounts payable 750 750

23) Based on the information in Table 3-1, assuming that no common stock was

repurchased during the year, the firm issued how much new common stock

during 2008?

a. $1,500

b. $1,000

c. $2,000

d. $500

24) What information does a firm’s balance sheet provide to the viewing public?

a. A complete listing of all of a firm’s cash receipts and cash expenditures for a

defined period of time.

b. A report of revenues and expenses for a defined period of time. 6

Final Examination

Introduction to Financial Management

c. A report of investments made and their cost for a specific period of time.

d. An itemization of all of a firm’s assets, liabilities, and equity as of the balance

sheet date.

25) Which of the following accounts does NOT belong on the asset side of a bal-

ance sheet?

a. Cash

b. Accounts receivable

c. Accumulated depreciation

d. Accruals

26) Which of the following accounts does NOT belong in the liability section of a

balance sheet?

a. Accumulated depreciation

b. Long-term debt

c. Accruals

d. Accounts payable

27) Which of the following accounts belongs in the equity section of a balance

sheet?

a. Dividends

b. Retained earnings

c. Long-term debt

d. Cash

Table 3-1

Jones Company Financial Information

December 2007 December 2008

Net income $2,000 $5,000

Accounts receivable 750 750

Accumulated depreciation 1,000 1,500

Common stock 4,500 5,000

Paid-in capital 7,500 8,000

Retained earnings 1,500 2,500

Accounts payable 750 750

28) Based on the information in Table 3-1, calculate the after tax cash flow from

operations for 2008 (no assets were disposed of during the year, and there

was no change in interest payable or taxes payable). Final Examination

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Introduction to Financial Management

a. $6,500

b. $3,375

c. $3,750

d. $5,500

29) Which of the following best describes free cash flow?

a. After-tax cash flows from operations, minus the increase in operating working

capital, minus the increase in fixed and other assets

b. EBIT, minus interest expense, minus income taxes

c. Gross profit, minus EBIT

d. Operating profit, minus interest and depreciation

30) Higher inventory turnover suggests that

a. the company’s inventory is more liquid.

b. the company’s inventory is somewhat obsolete.

c. the company has a higher inventory balance.

d. the company’s sales are higher.

31) The current ratio of a firm would be increased by which of the following?

a. Inventories are sold for cash.

b. Equipment is purchased, financed by a long-term debt issue.

c. Land held for investment is sold for cash.

d. Inventories are sold on a credit basis.

32) The current ratio of a firm would be decreased by which of the following?

a. Inventories are sold on a long-term credit basis.

b. Equipment is purchased, financed by a long-term debt issue.

c. Inventories are sold for cash.

d. Land held for investment is sold for cash.

33) Given an accounts receivable turnover of 20 and annual credit sales of

$400,000, the average collection period is:

a. 20 days

b. 45.625 days

c. 17.49 days

d. 18.25 days 8

Final Examination

Introduction to Financial Management

Table 4-1

Garland Company Balance Sheet

Assets:

Cash and marketable securities $500,000

Accounts receivable 800,000

Inventories 1,350,000

Prepaid expenses 50,000

Total current assets $2,700,000

Fixed assets 5,000,000

Less: accum. depr. (2,000,000)

Net fixed assets $3,000,000

Total assets $5,700,000

Liabilities:

Accounts payable $400,000

Notes payable 900,000

Accrued taxes 75,000

Total current liabilities $1,375,000

Long-term debt 1,200,000

Owner’s equity 3,125,000

Total liabilities and owner’s equity $5,700,000

Net sales (all credit) $8,000,000

Less: Cost of goods sold (3,500,000)

Selling and administrative expense (2,000,000)

Depreciation expense (250,000)

Interest expense (150,000)

Earnings before taxes 2,100,000

Income taxes (700,000)

Net income $1,400,000

Common stock dividends $500,000

Common Shares Outstanding 1,000,000

34) Based on the information in Table 4-1, the debt ratio is:

a. 21.1%

b. 48.8%

c. 45.2%

d. 22.6% Final Examination

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Introduction to Financial Management

35) Based on the information in Table 4-1, the operating profit margin is:

a. 32.4%

b. 28.1%

c. 17.5%

d. 44.8%

Table 4-3

Lesli Corporation

Balance Sheet Income Statement

Assets:

Cash $150,000 Sales (all credit) $6,000,000

Accounts receivable 350,000 Cost of goods sold (3,000,000)

Inventory 600,000 Operating expenses (900,000)

Net fixed assets 1,900,000 Interest expense (750,000)

Total assets 3,000,000 Income taxes (500,000)

Net income 850,000

Liabilities and owners’ equity:

Accounts payable $150,000

Notes payable 250,000

Long-term debt 1,200,000

Owners’ Equity 1,400,000

Total L. + O.E. 3,000,000

36) Based on the information in Table 4-3, assuming that the firm has no pre-

ferred stock, and paid $250,000 in common dividends, the firm’s return on

equity was:

a. 61%

b. 32%

c. 43%

d. 79

Final Examination

Introduction to Financial Management

37) The two principal sources of financing for corporations are:

a. debt and accounts payable

b. cash and common equity

c. common equity and preferred equity

d. debt and equity

38) Which of the following ratios would be the most useful to assess the risk as-

sociated with a firm being able to pay off its short-term line of credit?

a. Return on equity.

b. The fixed asset turnover.

c. The operating profit margin.

d. The acid test ratio.

39) You deposit $4,500 per year at the end of each of the next 25 years into an

account that pays 10% compounded annually. How much could you withdraw

at the end of each of the 20 years following your last deposit if all withdraw-

als are the same dollar amount? (The twenty-fifth and last deposit is made at

the beginning of the 20-year period. The first withdrawal is made at the end

of the first year in the 20-year period.)

a. $51,983

b. $22,128

c. $45,987

d. $38,323Final Examination

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Introduction to Financial Management

40) It is your 5th birthday today. You have a trust fund with $50,000 that is earn-

ing 8% per year. You expect to withdraw $20,000 per year for 4 years start

ing on your 21st birthday for graduate school. How much money will be left

in the trust fund after your last withdrawal (rounded to the nearest $10)?

a. $135,780

b. $91,30

c. $125,660

d. You will not have enough money to pay for graduate school.

41) How much money must you pay into an account at the end of each of 20

years in order to have $100,000 at the end of the 20th year? Assume that

the account pays 6% per year, and round to the nearest $1.

a. $2,718

b. $2,195

c. $1,840

d. $2,028

42) How much money must you pay into an account at the beginning of each of

20 years in order to have $10,000 at the end of the 20th year? Assume that

the account pays 12% per year, and round to the nearest $1.

a. $124

b. $111

c. $1,195

d. $139

43) Auto Loans R Them loans you $24,000 for four years to buy a car. The loan

must be repaid in 48 equal monthly payments. The annual interest rate on

the loan is 9 percent. What is the monthly payment?

a. $500.92

b. $597.24

c. $543.79

d. $563.82 12

Final Examination

Introduction to Financial Management

44) If you put $10,000 in an investment that returns 14 percent compounded

monthly what would you have after 12 years (round to nearest $10)?

a. $11,490

b. $53,140

c. $48,180

d. $61,270

45) If you want to have $5,000 in 10 years, how much money must you put in a

savings account today? (Assume that the savings account pays 4% and it is

compounded daily; round to the nearest $1).

a. $3,370

b. $4,102

c. $4,207

d. $3,352

46) You discover an antique in your attic that you purchased at an estate sale 10

years ago for $400. You auction it on EBay and receive $8,000 for your item.

What annual rate of return did you earn?

a. 20.00%

b. 34.93%

c. 30.47%

d. 200.00%

47) Assume that you have $165,000 invested in a stock that is returning

11.50%, $85,000 invested in a stock that is returning 22.75%, and

$235,000 invested in a stock that is returning 10.25%. What is the expected

return of your portfolio?

a. 18.3%

b. 15.6%

c. 12.9%

d. 14.8%

48) You are considering investing in a project with the following possible out

comes:

Probability of Investment

States Occurrence Returns

State 1: Economic boom 18% 20%

State 2: Economic growth 42% 16%

State 3: Economic decline 30% 3%

State 4: Depression 10% -25%Final Examination

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Introduction to Financial Management

Calculate the expected rate of return and standard deviation of returns for

this investment, respectively.

a. 2.18%, 1.69%

b. 8.72%, 12.99%

c. 7.35%, 12.99%

d. 3.50%, 1.69%

49) Assume that an investment is forecasted to produce the following returns: a

20% probability of a $1,200 return; a 50% probability of a $5,600 return;

and a 30% probability of a $9,500 return. What is the expected amount of

return this investment will produce?

a. $7,136

b. $6,125

c. $5,890

d. $4,533

50) You are considering investing in Ford Motor Company. Which of the following

are examples of diversifiable risk?

I. Risk resulting from possibility of a stock market crash.

II. Risk resulting from uncertainty regarding a possible strike against Ford.

III. Risk resulting from an expensive recall of a Ford product.

IV. Risk resulting from interest rates decreasing.

a. I only

b. I, II, III, IV

c. I and IV

d. II, III

51) Portfolio risk is typically measured by ________ while the risk of a single

investment is measured by ________?

a. beta, slope of the characteristic line

b. security market line, standard deviation

c. standard deviation, beta

d. beta, standard deviation

52) You are going to add one of the following three projects to your already well-

diversified portfolio.14

Final Examination

Introduction to Financial Management

PROJECT 1 PROJECT 2

Standard Standard

Probability Return Deviation Beta Probability Return Deviation

Beta

50% Chance 22% 12% 1.2 30% Chance 36% 19.5% 0.8

50% Chance -4% 40% Chance 10.5%

30% Chance -20%

PROJECT 3

Standard

Probability Return Deviation Beta

10% Chance 28% 12% 2.0

70% Chance 18%

20% Chance -8%

Assume the risk-free rate of return is 2% and the market risk premium is 8%. If

you are a risk averse investor, which project should you choose?

a. Either Project 2 or Project 3 because the higher expected return on

project 3 offsets its higher risk.

b. Project 2

c. Project 1

d. Project 3

53) The beta of ABC Co. stock is the slope of:

a. The arbitrage pricing line.

b. The security market line.

c. The characteristic line for a plot of returns on the S&P 500 versus

returns on short-term Treasury bills.

d. The characteristic line for a plot of ABC Co. returns against the returns

of the market portfolio for the same period.

54) Assume that WhirledCom has an issue of 15-year $1,000 par value

bonds that pay 6% interest, semi-annually. Further assume that to-

day’s required rate of return on these bonds is 9%. How much would

these bonds sell for today? Round off to the nearest $1.

a. $1,321

b. $1,066 Final Examination

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Introduction to Financial Management

c. $756

d. $864

55) The yield to maturity on a bond is the rate of return that equates the present

value of the bond’s future cash flows with the bond’s

a. book value.

b. liquidation value.

c. face value.

d. market value.

56) A corporate bond has a coupon rate of 9%, a face value of $1,000, and ma-

tures in 15 years. Which of the following statements is most correct?

a. An investor with a required return of 10% will value the bond at more than

$1,000.

b. An investor who buys the bond for $900 will have a yield to maturity on the

bond greater than 9%.

c. An investor who buys the bond for $900 and holds the bond until maturity

will have a capital loss.

d. If the bond’s market price is $900, then the annual interest payments on the

bond will be $81.

57) A $1,000 par value 12-year bond with a 9 percent coupon rate recently sold

for $980. The yield to maturity is:

a. 8.8%

b. less than 8%

c. 9 percent

d. greater than 9 percent

58) If the market price of a bond decreases, then

a. the coupon rate increases.

b. the yield to maturity increases.

c. the yield to maturity decreases.

d. the coupon rate decreases.

59) What is the yield to maturity of a corporate bond with 10 years to maturity,

a coupon rate of 6% per year, a $1,000 par value, and a current market price

of $1,147? Assume semi-annual coupon payments.

a. 4.7% 16

Final Examination

Introduction to Financial Management

b. 5.3%

c. 6.0%

d. 4.2%

60) What is the value of a preferred stock that pays a $3.50 dividend to an inves-

tor with a required rate of return of 9% (round your answer to the nearest

$1)?

a. $23

b. $39

c. $31.50

d. $17

61) Preferred stock differs from common stock in that

a. preferred stock dividends are fixed.

b. common stock investors have a required return and preferred stock investors

do not.

c. preferred stock investors have a higher required return than common stock

investors.

d. preferred stock usually has a maturity date.

62) Linen Supply Co. paid a dividend of $3.25 on its common stock yesterday.

The company’s dividends are expected to grow at a constant rate of 5.5%

indefinitely. The required rate of return on this stock is 17.5%. You observe a

market price of $27.50 for the stock. Should you purchase this stock?

a. Yes, the market price is below the intrinsic value of the stock.

b. Yes, but only if you can keep the stock for at least 5 years.

c. No, the growth rate in dividends is too far below the required return.

d. No, the market price is above the intrinsic value of the stock.

63) Chambers Corporation’s ROE is 18%. Their dividend payout ratio is 80%.

The last dividend, just paid, was $2.20. If dividends are expected to grow by

the company’s internal growth rate indefinitely, what is the current value of

Chambers common stock if its required return is 20%?

a. $12.89

b. $12.56

c. $15.43

d. $13.90 Final Examination

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Introduction to Financial Management

64) I-Sage, whose common stock is currently selling for $12 per share, is expect-

ed to pay a $1.80 dividend, and sell for $14.40 one year from now. What are

the dividend yield, growth rate, and total rate of return, respectively?

a. 15% 12% 27%

b. 20% 15% 35%

c. 15% 20% 35%

d. 10% 5% 15%

65) NewAge, Inc. paid a dividend yesterday of $2 per share. NewAge manage-

ment expects the dividend to increase next year to $3 annually. If the divi-

dend is expected to stay at $3 per year for the foreseeable future, what is the

value of the stock to an investor with a required rate of return of 10%?

a. $50.00

b. $30.00

c. $32.00

d. $7.50

66) Northwest Industries is considering a project with the following cash flows:

Initial Outlay = $2,800,000

After-tax operating cash flows for years 1-4 = $850,000 per year

Additional after-tax terminal cash flow at end of Year 4 = $125,000

Compute the net present value of this project if the company’s discount rate

is 14%.

a. $239,209

b. $725,000

c. -$138,561

d. -$249,335

67) Compute the payback period for a project with the following cash flows re

ceived uniformly within each year:

Initial Outlay = $100

Cash Flows: Year 1 = $40

Year 2 = $50

Year 3 = $60

a. 2.17 years

b. 3 years

c. 4 years

d. 3.17 years 18

Final Examination

Introduction to Financial Management

68) What is the net present value’s assumption about how cash flows are re-in-

vested?

a. They are reinvested at the IRR.

b. They are reinvested only at the end of the project.

c. They are reinvested at the APR.

d. They are reinvested at the firm’s discount rate.

69) Your firm is considering an investment that will cost $750,000 today. The

investment will produce cash flows of $250,000 in year 1, $300,000 in

years 2 through 4, and $100,000 in year 5. The discount rate that your firm

uses for projects of this type is 13.25%. What is the investment’s profitability

index?

a. 1.4

b. 1.6

c. 1.2

d. .2

70) If the NPV (Net Present Value) of a project with multiple sign reversals is

positive, then the project’s required rate of return ________ its calculated IRR

(Internal Rate of Return).

a. must be greater than

b. could be greater or less than

c. must be less than

d. Cannot be determined without actual cash flows.

71) Determine the five-year equivalent annual annuity of the following project if

the appropriate discount rate is 16%:

Initial Outflow = $150,000

Cash Flow Year 1 = $40,000

Cash Flow Year 2 = $90,000

Cash Flow Year 3 = $60,000

Cash Flow Year 4 = $0

Cash Flow Year 5 = $80,000

a. $8,520

b. $7,058

c. $9,872

d. $9,454 Final Examination

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Introduction to Financial Management

72) Your company is considering the replacement of an old delivery van with a

new one that is more efficient. The old van cost $30,000 when it was

purchased 5 years ago. The old van is being depreciated using the simpli-

fied straight-line method over a useful life of 10 years. The old van could be

sold today for $5,000. The new van has an invoice price of $75,000, and it

will cost $5,000 to modify the van to carry the company’s products. Cost

savings from use of the new van are expected to be $22,000 per year for

5 years, at which time the van will be sold for its estimated salvage value

of $15,000. The new van will be depreciated using the simplified straight-

line method over its 5-year useful life. The company’s tax rate is 35%. Work-

ing capital is expected to increase by $3,000 at the inception of the project,

but this amount will be recaptured at the end of year five. What is the incre-

mental free cash flow for year one?

a. $22,250

b. $18,850

c. $21,305

d. $19,900

73) The recapture of net working capital at the end of a project will

a. increase terminal year free cash flow by the change in net working capital

times the corporate tax rate.

b. increase terminal year free cash flow.

c. decrease terminal year free cash flow by the change in net working capital

times the corporate tax rate.

d. have no effect on the terminal year free cash flow because the net working

capital change has already been included in a prior year.

74) A new machine can be purchased for $1,000,000. It will cost $65,000 to

ship and $35,000 to modify the machine. A $30,000 recently completed

feasibility study indicated that the firm can employ an existing factory owned

by the firm, which would have otherwise been sold for $150,000. The firm

will borrow $750,000 to finance the acquisition. Total interest expense for

5-years is expected to approximate $250,000. What is the investment cost of

the machine for capital budgeting purposes?

a. $2,030,000

b. $1,530,000

c. $1,100,000

d. $1,250,000

e. $1,280,000 20

Final Examination

Introduction to Financial Management

75) PDF Corp. needs to replace an old lathe with a new, more efficient model.

The old lathe was purchased for $50,000 nine years ago and has a current

book value of $5,000. (The old machine is being depreciated on a straight-

line basis over a ten-year useful life.) The new lathe costs $100,000. It will

cost the company $10,000 to get the new lathe to the factory and get it

installed. The old machine will be sold as scrap metal for $2,000. The new

machine is also being depreciated on a straight-line basis over ten years.

Sales are expected to increase by $8,000 per year while operating expenses

are expected to decrease by $12,000 per year. PDF’s marginal tax rate is

40%. Additional working capital of $3,000 is required to maintain the new

machine and higher sales level. The new lathe is expected to be sold for

$5,000 at the end of the project’s ten-year life. What is the project’s terminal

cash flow?

a. $8,000

b. $6,000

c. $5,000

d. $3,000

76) Advantages of using simulation include:

a. a range of possible outcomes presented.

b. is good only for single period investments since discounting is not possible.

c. adjustment for risk in the resulting distribution of net present values.

d. graphically displays all possible outcomes of the investment.

77) A company has preferred stock that can be sold for $28 per share. The pre-

ferred stock pays an annual dividend of 5% based on a par value of $100.

Flotation costs associated with the sale of preferred stock equal $1.50 per

share. The company’s marginal tax rate is 35%. Therefore, the cost of pre-

ferred stock is:

a. 18.87%

b. 17.86%

c. 11.61%

d. 12.26%

78) Which of the following differentiates the cost of retained earnings from the

cost of newly-issued common stock?

a. The flotation costs incurred when issuing new securities.

b. The greater marginal tax rate faced by the now-larger firm.

c. The larger dividends paid to the new common stockholders.

d. The cost of the pre-emptive rights held by existing shareholders.Final Examination

21

Introduction to Financial Management

79) General Bill’s will issue preferred stock to finance a new artillery line. The

firm’s existing preferred stock pays a dividend of $4.00 per share and is sell-

ing for $40 per share. Investment bankers have advised General Bill that

flotation costs on the new preferred issue would be 5% of the selling price.

The General’s marginal tax rate is 30%. What is the relevant cost of new

preferred stock?

a. 15.00%

b. 7.37%

c. 10.00%

d. 10.53%

e. 7.00%

80) Cost of capital is

a. a hurdle rate set by the board of directors.

b. the average cost of the firm’s assets.

c. the rate of return that must be earned on additional investment if firm value

is to remain unchanged.

d. the coupon rate of debt.

81) Burns and Nuble is considering an investment in a project which would re-

quire an initial outlay of $320,000 and produce expected cash flows in years

1-5 of $87,385 per year. You have determined that the current after-tax cost

of the firm’s capital (required rate of return) for each source of financing is as

follows:

Cost of Long-Term Debt 8%

Cost of Preferred Stock 12%

Cost of Common Stock 16%

Long term debt currently makes up 20% of the capital structure, preferred

stock 10%, and common stock 70%. What is the net present value of this

project?

a. -$13,876

b. -$20,000

c. $0

d. $287,692

e. $1,568

82) Which of the following would be considered a variable cost in a manufactur-

ing setting?

a. Administrative salaries

b. Rent

c. Direct labor

d. Insurance 22

Final Examination

Introduction to Financial Management

83) Which of the following would not be a part of a firm’s capital structure?

a. Long-term bonds

b. Preferred stock

c. Short-term notes payable

d. Common stock

84) A firm’s optimal capital structure occurs where?

a. Stock price is maximized, and WACC is maximized.

b. Stock price is maximized, and EPS are maximized.

c. EPS are maximized, and WACC is minimized.

d. WACC is minimized, and stock price is maximized.

85) Which of the following would be considered the firm’s optimal capital struc-

ture?

a. Stock Price = $24, Earnings Per Share = $12, Cost of Equity Capital = 17%

b. Stock Price = $23, Earnings Per Share = $11, Cost of Equity Capital = 18%

c. Stock Price = $25, Earnings Per Share = $10, Cost of Equity Capital = 15%

d. Stock Price = $20, Earnings Per Share = $12, Cost of Equity Capital = 20%

86) The market value of a leveraged firm is equal to the market value of an unlev-

eraged firm

a. minus the present value of tax shields minus the present value of financial

distress costs minus the present value of agency costs.

b. plus the present value of tax shields minus the present value of financial

distress costs plus the present value of agency costs.

c. plus the present value of tax shields plus the present value of financial dis-

tress costs plus the present value of agency costs.

d. plus the present value of tax shields minus the present value of financial dis-

tress costs minus the present value of agency costs.

87) JBC Corp. declared a dividend of $2 per share, which was an increase of

25% from the prior year, yet JBC Corp. stock declined by 3% the day of the

announcement. RBG Corp. declared a dividend of $2 per share, which was

the same as the prior year, and its stock increased in value by 2% on the day

of the announcement. These events could be most readily explained by the

a. information effect.

b. expectations theory.

c. clientele effect.

d. residual dividend theory.Final Examination

23

Introduction to Financial Management

88) High dividends may increase stock values due to all of the following reasons

except:

a. higher dividends allow companies to increase their proportion of external

equity financing.

b. higher dividends are used to signal higher expected future earnings.

c. dividends are more certain than capital gains.

d. dividends are used as a tool to minimize agency costs.

89) According to the clientele effect,

a. even if capital markets are perfect, dividend policy still matters.

b. companies should change their dividend policies to please their target group

of investors.

c. companies should avoid making capricious changes in their dividend policies.

d. companies should have dividend payout ratios of either 100% or 0%.

90) While Captive, Inc. has been in business for over 50 years, newly developed

products pushed the firm’s year-over-year growth rate to 35% during the lat-

est three years. The firm is proud of its history of paying dividends, but the

vigorous recent growth of the firm has left it cash challenged. Which of the

following policies/procedures would you consider best under the circumstanc-

es?

a. Substitute a stock dividend for the current cash dividend.

b. Borrow long-term to pay the current dividend.

c. Enter into a long-term stock repurchase program.

d. Look seriously for a merger partner.

91) All of the following are rationales given for a stock dividend or split except:

a. the price will not fall proportionately to the share increase.

b. an optimum price range does not exist.

c. conservation of corporate cash.

d. there is positive informational content associated with the announcement.

92) Use the “percent of sales method” of preparing pro forma financial state-

ments to determine the projection for next year’s inventory. Make the follow-

ing assumptions: current year’s sales are $24,500,000; current year’s cost of

goods sold is $15,925,000; sales are expected to rise by 25%. The firm’s

investment in inventory in the current year is $3,621,300. What is the pro-

jection for next year’s inventory?

a. $5,555,000

b. $6,125,000 24

Final Examination

Introduction to Financial Management

c. $4,526,600

d. $3,981,250

93) Predicting a firm’s future financial needs includes all of the following steps

except:

a. estimation of projected sales and expenses.

b. determination of the firm’s financing needs for the period.

c. estimation of investment levels for current and fixed assets.

d. review of the firm’s sales revenues and expenses over all past planning peri-

ods.

94) Buster Enterprises’ projected sales for the first six months of 2008 are given

below:

Jan. $400,000 April $450,000

Feb. $540,000 May $480,000

Mar. $350,000 June $520,000

30% of sales are collected in cash at time of sale, 60% are collected in the

month following the sale, and the remaining 10% are collected in the second

month following the sale. Cost of goods sold is 70% of sales. Purchases are made

in the month prior to the sales, and payments for purchases are made in the

month of the sale. Total other cash expenses are $50,000/month. The company’s

cash balance as of February 28, 2008 will be $30,000. Excess cash will be

used to retire short-term borrowing (if any). Buster Enterprises has no short term

borrowing as of February 28, 2008. Assume that the interest rate on short-term

borrowing is 1% per month. The company must have a minimum cash balance of

$20,000 at the beginning of each month. What is Buster Enterprises’ earnings

before interest and taxes for April 2008?

a. $ 85,000

b. $159,000

c. $138,000

d. $135,000

95) All of the following are found in the cash budget except

a. accounts receivable.

b. new financing needed.

c. cash disbursements.

d. a net change in cash for the period. Final Examination

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Introduction to Financial Management

96) Fielding Wilderness Outfitters had projected its sales for the first six months

of 2008 to be as follows:

Jan. $ 50,000 April $180,000

Feb. $ 60,000 May $240,000

Mar. $100,000 June $240,000

Cost of goods sold is 60% of sales. Purchases are made and paid for two months

prior to the sale. 40% of sales are collected in the month of the sale, 40% are

collected in the month following the sale, and the remaining 20% in the second

month following the sale. Total other cash expenses are $40,000/month. The

company’s cash balance as of March 1st, 2008 is projected to be $40,000, and

the company wants to maintain a minimum cash balance of $15,000. Excess

cash will be used to retire short-term borrowing (if any exists). Fielding has no

short-term borrowing as of March 1st, 2008. Assume that the interest rate on

short-term borrowing is 1% per month. What is Fielding’s projected total receipts

(collections) for April?

a. $36,000

b. $124,000

c. -$4,000

d. $180,000

97) A company that increases its liquidity by holding more cash and marketable

securities is

a. going to have to sell common stock to raise the cash to become more liquid.

b. likely to achieve a higher return on equity because of higher interest income.

c. likely to achieve a lower return on equity because of the smaller rates of

return earned on cash and marketable securities compared to the firm’s other

investments.

d. going to maximize firm value because risk is decreased.

98) Which of the following actions would improve a firm’s liquidity?

a. selling bonds and increasing cash

b. increasing the company’s dividend payments

c. repurchasing stock

d. buying bonds

99) Which of the following actions would improve a firm’s liquidity?

a. buying machinery with long-term debt

b. purchasing inventories for cash

c. purchasing inventory on trade credit

d. purchasing inventory with long-term debt 26

Final Examination

Introduction to Financial Management

100) Your company buys supplies on credit terms of 2/10 net 45. Suppose the

company makes a purchase of $20,000 today. Which of the following pay-

ment options makes the most sense as a general rule?

a. Pay the bill on day 45 due to the time value of money.

b. Pay the bill as soon as possible to keep the supplier happy.

c. Pay the bill on day 10 to get the discount.

d. Either pay the bill on day 10 to get the discount, or wait until day 45.